In this week’s BlackRock’s Chart of the Week, they showed the following image:
They also wrote the following text:
Unfortunately, investors often take actions counterintuitive to investing best practices. In an ideal world, investors “buy low, sell high.” Though the rule seems simple, we’ve often seen investors do the exact opposite, especially during volatile times. For a few examples, look at historical mutual fund flows versus the performance of the S&P and note how the most flows went out when market prices dropped…and were set to rally.
This isn’t a phenomenon of investor psychology, it’s a phenomenon in misrepresenting information. In fact, this phenomenon occurs due to the definition of how markets work. Excess selling pressure reduces prices: for every seller, there must be a buyer, and if there is no buyer at the current price, the seller must reduce their asking price to find a buyer. Ipso facto, if there are excessive equity outflows, prices must decline. The two aren’t coincidental, they’re inherently linked!
You’ll notice how BlackRock used 12-month fund flows, which will appropriately lag the equity returns. Instead of looking at the zero cross-over line, which the eye is naturally drawn towards, look at the inflection points and see how nicely they line up with market tops and bottoms. Consider the following graph, which shows monthly flows (from TradersNarrative):
You’ll notice that US Equity Funds had positive flows after March 2009. Wait a second … doesn’t that line up with … oh, right — the market bottom.
This is similar to when people say, “the only thing that goes up in a bear market is correlation.” It’s another tautology. For the S&P 500 to continuously move in the same direction, the underlying stocks have to move in the same direction. If all the underlying stocks are moving in the same direction, then there is high correlation. Correlation is a statistical measure — it is not intrinsic to markets; it is not a law that governs how markets behave.
So while there is plenty of evidence from behavioral finance about irrational investors, this isn’t it: BlackRock is just explaining how markets work.
Corey Hoffstein
Corey is co-founder and Chief Investment Officer of Newfound Research, a quantitative asset manager offering a suite of separately managed accounts and mutual funds. At Newfound, Corey is responsible for portfolio management, investment research, strategy development, and communication of the firm's views to clients. Prior to offering asset management services, Newfound licensed research from the quantitative investment models developed by Corey. At peak, this research helped steer the tactical allocation decisions for upwards of $10bn. Corey holds a Master of Science in Computational Finance from Carnegie Mellon University and a Bachelor of Science in Computer Science, cum laude, from Cornell University. You can connect with Corey on LinkedIn or Twitter.
